Why the Short Term Upside Bias?

I mentioned yesterday why I was short term bullish. Quite a few emailers and commenters asked for greater specifics, and whether this changes my longer term Ursine perspective.

Nothing has changed long term, as the macroeconomic analysis continues to suggest that an eventual slowing of the economy is more than likely. Housing sales are softening, the yield curve is inverted, and the consumer is slowly tiring. Inflation, at both the retail and wholesale level -- core and non-core alike, -- is still rearing its ugly head.

Resolving the dispute is a relatively simple matter of carefully considering timelines and expectations. Technicians tend to respond to shorter term market moves (like this week’s!), while Economists ply their trade over much longer time frames. I find that combining these two dissimilar disciplines allows me to develop a view towards both the immediate and distant futures.

Why the Short Term is Bullish

Despite the up/down action this week, the Technicals favor an upside bias over the next month or so. There are numerous reasons for this.

Most of the major indices -- the Russell 2000, DJIA, the Dow Transports, the NYSE, The S&P400 midcaps -- are above their upwards sloping 50 and 200 day moving averages. The notable omission is the NDX, which remains just below its downward sloping 50 day. This is the most basic of trend indications.

We also see a continually expanding margin debt -- which is a net positive for equities short term. When this measure gets to extremes, it’s a warning sign. In March 2000, for example, the margin debit actually exceeded the Free and other credit balances, $21.4 billion to $17.4B. That told you that individual investors were rather extended. As of the end of 2005, the positive credit balances were nearly $55B, while the margin debt was $22.4, so that ratio is not at an extreme.

Studies have shown that as margin debt expands, it helps to fuel bull markets. Once the market turns south, however, it rapidly dries up, adding to the downside momentum. This remains a bullish factor, at least for now.

Sentiment is also on the side of the Bulls. Ignore the anecdotal evidence and stick with the actual data. Nearly 30% of Market advisers now read Bearish, and that tends to be the level where in bull markets, we get rallies (it’s different in confirmed cyclical bears).

Further, noted technician Stan Weinstein observed this week that Public short selling is at a very high 8.3%, while NYSE Member Short Selling measures “an unbelievably low at a reading of 40.3% (which is the lowest reading since mid-September 2001, which was registered in the immediately after the 9/11 tragedy).” That combination of the public shorting while the smart money chooses not to have historically led to market advances.

And, we are still in the seasonally best period for equities.

Long Term: Watch the Signals

So despite the negative economic future, with all these positives and the Indices near new highs, why have any concerns beyond the near term?

The answer lies between the long and short term. Over an intermediate term, there are numerous technical warning signs. I use these signals to help alert me to a possible change in trend or character of the markets. Investors ignore these at their own peril.

As mentioned in the Paul Desmond interview, the advances have become increasingly narrow. An increasingly narrow advance, with less issues participating in the gains, and a small number of 52 week high list – despite the indices being at or near multi year highs – all suggest a Bull market that is in the process of tiring. Note that the most active NYSE issues have a negative bias; I prefer to see that measure be moving smartly ahead on rallies.

This implies a major sector rotation, and not a new rush of money into equities.

Then there’s the volume issue. Of the major ETFs, only Semiconductor HOLDRs (SMH) managed to show a gain in volume from Tuesday’s sell off to Wednesday’s snapback rally. Even the QQQQs were softer on Wednesday. The broader Nasdaq Comp and the NDX did show volume gains, while the NYSE, S&P and Dow did not. Low volume on up days vs. heavier volume on down days is also a signal that a high degree of caution is warranted for equity investors.

Disclaimer

Disclaimer

The information on this site is provided for discussion purposes only, and are not investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities.